Labor Cost
Labor cost is the total expense of employee compensation, including wages, salaries, overtime, payroll taxes, benefits, and worker's compensation. For product-based businesses, labor cost can be classified as either direct (employees who work directly on creating products) or indirect (supervisors,
Labor Cost Definition
Labor cost is the total expense of employee compensation, including wages, salaries, overtime, payroll taxes, benefits, and worker's compensation. For product-based businesses, labor cost can be classified as either direct (employees who work directly on creating products) or indirect (supervisors, administrators, facility staff). Service businesses typically treat most labor as a direct cost.
Labor Cost in Practice — Example
A small cabinet shop employs two carpenters at $28/hour who build custom furniture, plus an office manager at $45,000/year who handles orders and scheduling. The carpenters' wages and associated payroll taxes are direct labor costs that go into Cost of Goods Sold. The office manager's salary, benefits, and payroll taxes are indirect labor costs that appear as operating expenses. When pricing a custom dining table, the shop includes the direct labor hours in their COGS calculation.
Why Labor Cost Matters for Your Books
Labor is often a business's largest expense, so tracking it accurately is critical for profitability analysis. Misclassifying direct vs. indirect labor distorts your gross margins and makes it impossible to price products or services correctly.
For job costing and project-based businesses, labor cost tracking determines whether individual projects are profitable. If you're bidding $50/hour for consulting work but your true labor cost (including benefits and taxes) is $65/hour when overhead is allocated, you're losing money on every billable hour.
Labor costs also directly impact cash flow. Unlike materials you can buy on payment terms, payroll hits every week or two weeks like clockwork. Understanding your labor cost per period helps with cash flow planning and budgeting.
How Labor Cost Shows Up in QuickBooks
In QBO, labor costs flow through Payroll (if using QBO Payroll) or are entered manually via checks/expenses. Direct labor costs should be categorized to Cost of Goods Sold accounts, while indirect labor goes to operating expense accounts like Salaries & Wages, Benefits, and Payroll Taxes. Use Classes or Projects to allocate direct labor to specific jobs. The Payroll Summary report shows total labor costs by employee and category. For accurate job costing, track labor hours by project and multiply by the fully-loaded hourly rate (wage plus benefits plus taxes).
Common Mistakes
FAQ
Q: Should I include owner/manager salaries in labor cost?
A: Yes, if they work directly on revenue-generating activities. An owner-operator cabinet maker's time belongs in COGS. An owner who only does administrative work belongs in operating expenses.
Q: How do I calculate fully-loaded labor cost?
A: Base wage + payroll taxes (usually 7.65% FICA plus state/federal unemployment) + benefits + workers' compensation. For estimation, multiply base wage by 1.3-1.4 as a starting point.
Related Terms
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Related Terms
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